A bearish trend doesn't remain forever. After a long bearish period, the price of a stock becomes undervalued, drawing more buyers, especially the smart money. These early buyers start accumulating the asset, causing a halt in the downtrend and eventually a reversal. Knowing this pivot point is essential to make an early entry. Often charts give signs before the actual reversal happens, and as a trader you should pay attention to these signals.
One such signal of bullish reversal is, Three White Soldiers candlestick pattern. In this post, you will learn about this pattern in detail. You will learn to identify this pattern, the psychology involved, and finally how to take trades based on this pattern and how to enhance the reliability.
Let's begin.
What is Three White Soldiers Candlestick pattern?
The Three White Soldiers pattern is a bullish reversal pattern. The pattern has three candles. The name of this candle pattern is 'White Soldiers' because initially Japanese candles used to be of white and black colour, where white meant a bullish candle and black denoted a bearish candle. Now colours green and red are used for bullish and bearish days.
So, Three White Soldiers mean three bullish candles. That doesn't mean any three consecutive bullish candle is White Soldiers pattern. To be a valid Three White Soldiers pattern, the candles should be of specific morphology which we will discuss next in the identification part.
How to identify the Three White Soldiers candlestick pattern?
As stated earlier, identifying this pattern requires more than seeing three green (or white ) candles. To filter out noise and identify the pattern, you need to look for specific candle morphology and place of occurrence, which are:
a) The trend context: The pattern must appear after a downtrend or a period of consolidation. Frequently, you will see three big green candles in the middle of a rally. That is not Three White Soldiers pattern, it is just momentum candles because of massive buying.
b) The first candle should be a big green candle that should close decisively higher than it opened.
c) The second candle should open within the body of the first candle, ideally between the close and midpoint of the first candle. This candle should close above the high of the first candle.
d) The third candle should open within the body of the second candle and close above the high of second candle.
e) All these three candles should have a small or non-existent upper wicks.
The psychology behind the Three White Soldiers pattern-
Unlike other reversal patterns like Morning star where a change of sentiments take time, in Three White Soldiers there is abrupt change of sentiment from bearish to bullish right from the first candle.
In the first candle of the pattern, the buyers step in after a downtrend, and the entry is strong enough to close the day near the high. Buying from informed investors who see the stock as undervalued forms this first candle. Frequently, this occurs near a strong support zone.
The second candle open lower suggesting a final intervention from the sellers. However, once again buyers step in to take price further. The traders who have shorted the stock now start buying back to close their positions, triggering another candle formation with close near high.
On the third candle price continues its northward journey both because of short covering and technical traders who start seeing the reversal signal in their systems.
How to validate the Three White Soldiers pattern?
Even though people consider the Three White Soldiers a reliable sign, validation through other signals is still necessary. Here are a few ways you can validate this pattern.
The Volume validation- Volume is the fuel that drives the market. In a Three White Soldiers pattern, ideally volume should increase with each candle. The first candle of the pattern should have moderate volume, the second candle should have higher volume and the third candle should have the highest volume.
The RSI validation- RSI below 30 (oversold) when the pattern starts forming or shortly before is a great signal. A RSI range shift once the pattern forms is another positive signal that suggests the pattern is genuine. If RSI is already above 70 when the pattern is fully formed, wait for the pullback before entering the trade.
The Support validation- Ideally a Three soldiers pattern should form at or near a strong support. A pattern formed in the middle of a trend is not valid, it only suggests momentum within a trend.
The trend context- The Three soldiers is a bullish reversal pattern, so a prior downtrend must be present. A prior downtrend that is losing strength should always be present for a valid Three white soldiers to form.
How to trade Three White Soldiers pattern?
Trading a pattern doesn't mean hitting that 'buy' button and wait for the market to go in the intended direction. Trading means planning your entry, define your risk management rules, and envisage a logical target to achieve. We will discuss each of these facets of trading this pattern in this section. First, let's start with entry.
You can plan your entry in two ways while trading a Three White Soldiers-
Aggressive entry- In this kind of entry, you enter a buy trade as soon as the pattern is confirmed. Either at the close of the 3rd soldier or opening of the next candle. The benefit is you don't miss the trade if the stock goes parabolic after the pattern. However, the drawback of the aggressive entry is that you buy at high and you have to put a wider stop-loss.
Conservative entry- In this kind of entry, you wait for the stock to pullback a bit before entering the trade. Frequently, by the time the Three White Soldiers pattern forms, the price has already overstretched on the upside.
The stock more often than not gives a pullback up to the midpoint or high of the second candle. This area could be your probable buying zone. The advantage is you pay a better price for the stock and your risk to reward ratio becomes favourable. The disadvantage, however is, you might miss the trade if the stock never pulls back.
Once you have entered a trade, you need to put a stop-loss to manage your risks.
When trading the Three White Soldiers pattern, traders typically place a stop-loss just below the low of the first candle. From here you can trail your stop loss as the trade goes in your favour.
Once trade goes in your favour, you can mark the next key resistance area as your target or continue using trailing stop-loss to be in the game as long as trend thrives.
Understand this through a chart.
Common mistakes to avoid:
Even some experienced traders make mistakes while trading with this pattern. Here are the most common traps:
Ignoring the size of the wicks- In the Three White Soldiers pattern, the wicks should be small or nonexistent, especially the upper wick. Look closely at the second and third candles of the pattern. Do they have long upper wicks? If the candles are getting smaller and the wicks are getting longer, this is not the White Soldiers pattern.
It is a variation called an "Advance Block". An advance block suggests the buyers are getting exhausted and is a bull trap.
Ignoring the volume- Volume confirms the price action. Traders should look for increasing volume with the three whites. A decreasing volume suggests the move is not genuine and might lose steam.
Ignoring the trend- A valid Three White Soldiers should form after a downtrend. Ignore patterns formed in the middle of an uptrend or in a sideways market.
The Bottom Line
The Three White Soldiers Pattern suggests a shift of trend from a downtrend to an uptrend. It is a three candle pattern having three large bullish candles with small upper wicks.
You should always validate the pattern with additional tools or signals. Always analyze it with trend context. Volume and RSI are other indicators that you can use to differentiate a genuine pattern from invalid ones.
Trade this pattern with solid risk management in place and trail stop-loss once trade goes in your favour.
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